Institutional Investment Horizons and Labor Investment Efficiency

Abstract

We investigate how the investment horizon of a firm’s institutional shareholders affects the efficiency of its labor investments. We argue that long-term investors have greater incentives to engage in effective monitoring, which reduces agency conflicts in labor investment choices. Consistent with this argument, we find that abnormal net hiring, measured as the absolute deviation from net hiring predicted by economic fundamentals, decreases in the presence of institutional investors with longer investment horizons. Firms dominated by long-term shareholders reduce both over-investment (over-hiring and under-firing) and under-investment in labor (under-hiring). The monitoring role of long-term investors is more pronounced for firms facing higher labor adjustment costs. These results are robust to alternative model specifications and variable definitions, as well as to tests controlling for the endogeneity in the institutional shareholders’ investment decisions. Overall, our findings suggest that institutional investors play an important role in firm-level employment decisions.